Showdown: Greenspan vs. Fannie

You just get the feeling that Alan Greenspan, who at 78 years of age is in the twilight of his career, has decided to chuck the obfuscation and the Washington-speak and say what he really thinks. For folks who have spent the last two decades consulting their Greenspan-English dictionaries there's a sense of wonderment. What took him so long?

On Tuesday Greenspan followed up on a Federal Reserve report from last month, stating before Congress that government-sponsored entities (GSEs) Fannie Mae (NYSE: FMN  ) and Freddie Mac (NYSE: FRE  ) would threaten the economy if they were allowed to continue to grow apace. As it is, these two hold more than $2 trillion in debts and are allowed to grow virtually unchecked as a result of their implied backing by the Federal Government. Not that Greenspan's comments needed much of a translation this time, but here we are nonetheless: These entities are growing too big to be allowed to fail.

These GSEs have enormous debt portfolios, which are backed by thin levels of assets. Should there be a dislocation in the housing market -- one of those multiple-sigma events that are supposed to never happen and yet tend to somewhat more often than that -- the risk to the overall markets, housing, debt, and equity would be severe. The Fed's St. Louis President, William Poole, followed up Greenspan's comments in a speech in Charlotte that called for the GSEs to hold more capital, essentially lowering their leverage.

Greenspan said that Fannie and Freddie have exploited their implied-government guarantees to corner the market for single-family mortgages over the last 20 years. He stated that while these companies have played vital roles in creating a market for mortgage-backed securities, enabling homeowners to enjoy lower rates and higher liquidity, their sheer size and lack of controls on growth call for "preventative action."

What a government guarantee does, essentially, is state that should Fannie and/or Freddie have to default on their debt, the federal government would step in and fulfill their obligations. But there's really no such thing as "federal money," it's all taxpayer funds. Should the Federal Government have to step in, the funds will come, indirectly, from all of our pockets. At present, given a government backstop and a paucity of restraints on their issuing more and more debt, why wouldn't Fannie and Freddie simply continue to engage in such highly profitable activity? That's the textbook definition of a "moral hazard."

Greenspan advocated strict limitation and regulation of the enterprises that correspond to the strictures placed on the big money-center banks like Citigroup (NYSE: C  ) , Wachovia (NYSE: WB  ) , and JPMorgan (NYSE: JPM  ) . Further, Greenspan recommended that the acquisition and debt activities be capped and controlled by Congress.

But there's a bit of a third-rail element to such actions. Congress is fully cognizant that such a move would have the effect of curtailing the massive spate of home buying ongoing throughout the country. The GSEs, whose ability to lobby in Washington might be unparalleled, naturally oppose such caps, saying that they would force more of the mortgage industry to rely on banks -- which are not structured or mandated to lower overall mortgage costs.

Yow. I think what's clear here is that additional regulation and limits on Fannie and Freddie are coming down the pike. They may have facile lobbying skills and political power in Washington, but it seems that they're up against a Federal Reserve Chairman who just isn't influenced by such concerns anymore. Greenspan emphasized that these companies are well run and in no danger, but that it would be impossible for them to fully insure against a massive housing market dislocation. That would put the onus back on taxpayers, something Greenspan does not find acceptable.

Who knows how this one ends, but it's an extremely important discussion, and Greenspan's got the influence to blow the wind in directions that the GSEs really don't want.

Bill Mann owns none of the companies mentioned in this article.


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